Australia rate cut may not be enough for stocks

SarahTurner

An ANZ Bank branch in Sydney. Many Australian banks are now shifting rates on their own, without regard to the central bank’s policy rate.

SYDNEY (MarketWatch) — The Reserve Bank of Australia is widely expected to cut interest rates Tuesday, but the move may be greeted with no more than a shrug from stock market investors.

Cuts are on the cards as some fresh doubts resurface about the strength of the Australian economy, with the global picture also worrying as debt concerns rise again for Europe and the strength of economic growth in China looks less certain than before.

The forward-rates market has fully priced in a 25 basis point cut from the RBA on Tuesday, a move that would take the country’s key cash rate down to 4.0%.

The minutes of the Reserve Bank of Australia’s previous meeting, earlier this month, indicated that the RBA was open to adjusting monetary policy, provided inflation remained tame. After the release last week of a consumer price index (CPI) gain of just 0.1%, lower interest rates became almost a certainty. Read report on Australian consumer inflation.

Stocks might normally be expected to benefit should rates fall, in part as lower interest rates reduce the attractiveness of cash as an asset class for investors. Investors have piled into cash in Australia over the past few years, taking advantage of attractive deposit rates as well as the relative safety of cash in somewhat volatile markets.

For the policy interest rate, “lower is better because it reduces the liquidity drag of high cash yields,” said Paul Brunker, equity strategist at J.P. Morgan.

But markets are forward looking, and equities in Australia have arguably already priced in easing from the RBA, with the benchmark S&P/ASX 200 index (XJO) up 0.6% so far this month, outpacing many other Asia-Pacific share markets.

Only the Shanghai and Hong Kong markets — where easing expectations are also on the radar for investors — have performed better so far in April, with the Shanghai Composite Index (000001) up 6.1% and Hong Kong’s Hang Seng Index (HSI) up 1.3%.

The move in the Australian equity market has been driven by “defensive yield or bond proxies — regulated utilities, Telstra Corp. (TLS)
TTRAF, -0.74%
real-estate investment trusts — [which] outperformed on the CPI print, following bonds and rate futures,” said Brunker at J.P. Morgan.

Indeed, Telstra on Friday reached a level not seen since late 2009, having gained around 5% this week.

Dollar doldrums

Analysts believe that savage rate cuts are needed to effect any change to the trends already embedded within the economy, including a strong Australian dollar.

The currency’s strength has worked its way through to the Australian economy by discouraging tourism, increasing competition for exporters and making life more difficult for manufacturers.

Highs cost and very narrow margins over a number of industries are adding up to a situation where “we’re no longer as competitively placed as we once were,” said Jamie Spiteri at Shaw Stockbroking.

Relatively high interest rates in Australia have been a key prop underpinning the Australian dollar, which continues to trade above parity with the U.S. dollar, even ahead of a likely interest rate cut.

That relationship is unlikely to change with a quarter point cut, as 4.0% is still far higher than the ultra-low rates currently found in other developed financial markets. Indeed, roughly 80% of Australia’s government debt is currently held by overseas investors.

And, like the stock market, currency markets appear to have already adjusted to a quarter-point rate cut, with the Australian dollar
AUDUSD, -0.4783%
softening over the past few weeks but remaining above parity with the U.S dollar, while currency-exposed stocks have gained ground over the past few months.

A quarter-point cut is also unlikely to kick start consumer spending in a country where banks are raising mortgage rates out of cycle, due to higher funding costs.

As Deutsche Bank strategist Tim Baker said, a cut of “25 basis points — it’s nice, but you also have to take into account that the banks are repricing on their own now.”

“The way I would look at it, is a very gentle easing cycle. So far it’s been 50 basis points [worth of cuts], but the banks have repriced, so it’s maybe 25 basis points through to borrowing rates,” Baker said.

Buying into the banking sector on the hope that rate cuts will stimulate consumer spending isn’t a good idea, according to Brunker at J.P. Morgan.

“The RBA has no intention of firing up credit growth, and the banks would struggle to fund it anyway because wholesale capacity is not there,” he said.

So, “we expect the market to remain in its range. Accordingly, we lean to stocks or sectors with value drivers which are largely independent of the macro environment or priced for low expectations,” the analyst said.

Brunker’s view is shared by Baker at Deutsche Bank: “If there was going to be much more aggressive rate cuts, 100 basis points or 200 basis points, I’d have to start thinking about my view. But I struggle to see what’s going to push the RBA anywhere near that. The domestic or global scene would have to get much worse, and it’s hard to see that happening,” he said.

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